Reduce risk in your portfolio Part 1 – Investment grade over high yield

Authors – Liz Moran and Leigh Winton

One of our recurring themes is to reduce risk in your portfolio. We make some suggestions in investment grade bonds in AUD and USD

We are now in the later stages of the credit cycle according to Mark Bayley in his Macro credit outlook: Mid-year update. At the end of the paper, Mark suggests eight themes which we will bring to you in coming weeks.

This week we start with his first – investment grade over high yield.

Few clients have a 100% investment grade portfolio as the returns are low at this point in the cycle. If the investment grade bonds have a short term until maturity, returns are likely to be even lower. For that reason, we don’t necessarily recommend you sell all your high yield securities, rather be comfortable with the mix and the high yield names you invest in. Moving up the capital structure to a guaranteed or secured position also helps risk management in high yield bonds.

Investment grade securities are perceived as much lower risk than high yield and statistically proven to be so over time. Credit rating agency, Standard and Poor’s publish an annual default rating table, specifically identifying the percentage chance of default given the credit rating and the term to maturity.

The row I tend to focus on is the ‘BBB’ rating, being the lowest investment grade. Running along the row, you can see that a BBB rated bond with a five year term has a probability of default of 1.70%, which is very low. Moving down that five year column, you’ll see the probability rises dramatically for BB rated bonds to 7.11% and for single B rated bonds to 17.88%.

Over time, investment grade bonds (BBB- and above) have proven to be safer investments than high yield, being BB+ rated or lower (including not rated at all).

Australian Dollars

In Australian dollars, our themes prefer defensive sectors like infrastructure, utilities and some financials. This is because these sectors tend to exhibit less volatility in stressed times, and consequently they perform relatively better than more cyclical or higher risk sectors.

Preferred Australian dollar investment grade bonds include both Sydney Airport inflation linked bonds. These bonds are for essential monopoly infrastructure that is the gateway to Australia and still able to provide strong returns of CPI + 2.20%pa for the short dated 2020 maturity and CPI + 2.78%pa for the 2030s.

Other infrastructure names to consider include – Adani Abbott Point Terminal, Australian Gas Networks, Asciano and Praeco. See the table below for more information.

Financials we like include the IAG floating rate subordinated debt with a first call in June 2024 and a yield of BBSW + 1.59%pa and the fixed rate Liberty 2020 bond with a yield of 4.41%pa.

Shorter dated RMBS are highly sought after offering floating rate coupons and a pick up in yield over other similarly rated financials. This is likely to compensate for probable illiquidity in the case of a stressed market.

Investment grade AUD

Source: FIIG SecuritiesNote: Inflation linked bonds assume CPI is 2.5%paPrices accurate as at 5 June but subject to change

US Dollars

Here are just a few investment grade USD bonds. There are also some options in euro and sterling.

Just last week we added healthcare group, HCA to the DirectBond list. HCA is headquartered in Nashville, Tennessee, and is the largest for-profit hospital operator in the US (by revenues) and a leading comprehensive, integrated provider of health care and related services.

The group currently operates 179 hospitals with 47,000 and 120 freestanding surgery centres. Almost 50 per cent of its hospitals are located in Texas and Florida, but HCA operates across 20 US states and in the United Kingdom. You can find its Factsheet here.

QBE is a firm favourite with a yield to call of 5.83%pa, exceeding other USD investment grade bonds on the list but be aware as it’s an insurer and the bond is subordinated it has a final maturity of June 2046

Investment grade USD

Source: FIIG SecuritiesNote: Inflation linked bonds assume CPI is 2.5%paPrices accurate as at 5 June but subject to change

Please contact your relationship manager or Portfolio Strategy Services if you would like to discuss your options.

Disclaimer The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.

Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.

No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.

FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.FIIG Securities Limited (‘FIIG’) provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. FIIG’s AFS Licence does not authorise it to give personal advice. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. FIIG, its staff and related parties earn fees and revenue from dealing in the securities as principal or otherwise and may have an interest in any securities mentioned in this document. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not provide tax advice and is not a registered tax agent or tax (financial) advisor, nor are any of FIIG’s staff or authorised representatives. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.

An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. FIIG may quote to you an estimated yield when you purchase a bond. This yield may be calculated by FIIG on either A) a yield to maturity date basis; or B) a yield to early redemption date basis. Some bond issuances include multiple early redemption dates and prices, therefore the realised yield earned by you on the bond may differ from the yield estimated or quoted by FIIG at the time of your purchase. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.
The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.

Subscribe to The WIRE newsletter

About FIIG

At FIIG, fixed income is our sole focus. We enable investors and issuers to directly access a broad range of fixed income products and services. Not only do our customers have the most up to date market research and the expertise of our in-house professionals at their fingertips, they also have access to deposit rates from an extensive range of APRA regulated banks, credit unions and building societies. At FIIG we're guided in everything we do by our clear and single-minded purpose: Creating access to fixed income investments you can trust.

FIIG provides general financial product advice only. For a copy of our disclaimer please refer to fiig.com.au/disclaimer* Based on FIIG’s high yield sample portfolio. Click here to view. Subject to change and before fees. Please see our FSG for any applicable fees.